Preparing to Sell Your Business
At some point in time, you’re going to make the decision to sell your business. It’s a big decision and an emotional time because in many cases you could be selling your life’s work. It might have taken you 10, 20 or 30 years to build this asset so don’t expect to sell it in 5 days.
It’s an emotional time because you’ll reflect on the long hours, staff issues, customer dramas and the financial risks you took to get up and running. Sadly, in business, passion and hard work doesn’t always translate into profit. Working 7 days a week and forfeiting holidays won’t necessarily add value to the business and the buyers want to see financial proof that justifies the asking price. The figures are a reflection of the owner’s years of blood, sweat and tears.
As the vendor, your objective is to maximise the sale price and protect the goodwill you have created. You also want to look after your loyal staff and make sure they still have a job. You also want to ensure your customers continue to get the service they deserve and have become accustomed to over the years. On the other hand, buyers view the purchase as a business transaction. They are now taking on the risk and possibly debt, so they expect a reasonable return on their investment. When assessing the value of a business, most buyers are focused on the historic revenue and profit figures. Unfortunately, in many instances, the vendor let’s their emotions cloud their judgment which explains why they think the business is worth more than the market will pay. The emotion creates commotion.
You need to understand that selling your business is a process that can take months. You need to plan the sale if you want to achieve the best possible outcome for you, your staff, and your customers. A lot of the focus will be on the sale price so before you start talking to prospective buyers or list the business for sale, you need to get a realistic valuation. It’s good idea to consult with a business broker who ideally specialises in your industry.
There are several different business valuation methods, however, as a guide, most businesses are valued on a multiple of gross revenue or net profit. The multiple can vary dramatically between industries. Generally speaking, most industries tend to follow a specific valuation method and business brokers and valuers will usually have access to industry data including recent sales of similar businesses.
While every business is different, the valuation could hinge on a several factors including:
- Industry Type
- Size of Business – Total Revenue
- Return on Investment – Annual Profit & EBIT (Earnings Before Interest and Tax)
- Longevity and History of the Business
- Reasons for Selling – Retirement vs Distressed Sale
- The Business Assets – Equipment (age, working order and debt free)
- Value of Inventory and Intellectual Property
- Projected Cash Flows & Value of Future Contracts
- Lease on the Premises – Terms and Transferability
- Structure of the Sale and the Terms of Sale.
Let’s examine some key factors that impact on the value of a business.
1) Financial Performance
When assessing the value of a business, potential buyers and their advisors will focus on your financial performance starting with your top line revenue. They will compare your turnover to prior year figures and buyers ideally want to see a business that is growing not slowing.
Buyers will also focus on your bottom line profit because this is their likely return on investment. In some industries the business valuation is based on a multiple of the annual profit while other industries (such as professional service businesses) base the valuation on a multiple of gross revenue. In either case, vendors will often talk the business up and sell the growth potential, however, buyers are focused on profits not potential.
When looking at the financial performance of the business, trends are also very important. Buyers want to see the revenue and profit on an upward trajectory. Revenue that is flatlining or in decline can be a red flag for buyers while ‘hockey stick growth’ will always make a business look attractive. If you’ve made the decision to sell you can’t afford to take your foot of the accelerator. You might be burnt out, but you can’t afford to let the business performance fall away. It has to be business as usual right up to settlement date because plenty of sales fall over at the eleventh hour.
When buyers are evaluating your business, they generally require at least three years' worth of financial information and the more formal your financial statements the better. You should provide financials produced or certified by an accountant, not internally generated statements from your accounting software. Certified financial statements will help buyers with their due diligence and if there’s one aspect that will slow or jeopardise the sale, it’s issues with the figures. For that reason, we recommend you always have your business ‘investor ready’ that means having up-to-date financial statements (profit and loss statement and balance sheet) plus income tax returns for the last 3 financial years.
The timing of your sale can also impact on the value of the business. For example, in recessionary times, finance is generally harder to raise and the appetite from buyers to purchase businesses is usually subdued. Again, business owners should always be investor ready and it’s no secret that a well prepared business will generally sell faster and for more money.
The law of supply and demand influences prices and a market saturated with a supply of similar types of businesses will give buyers more options and price negotiation power. By contrast, if there is high demand from buyers with a shortage of businesses on the market, vendors should get a premium sale price. The key takeaway here is, build a business with a competitive a point of difference to differentiate your business from the rest of the pack.
Business owners often hang on too long and defer the sale until the ‘time is right’. If you want to achieve top dollar on sale you need to take into account the market and economic conditions. If you’re burnt out it’s highly unlikely that you’ll keep growing the business so it’s best to sell when the key performance indicators are all positive. If the business is in decline the buyers will devalue the operation and there are plenty of bargain hunters looking for distressed businesses with a ‘fire sale’ price tag.
If you sense your sales or profits are likely to tumble in the future, it might be time to cash in your chips. For example, if a major competitor or franchise is opening a new store in a prime location close to you and they offer cheaper prices, that might be the trigger to list your business for sale. If you know one of your major customers is selling or closing their business this could put your business at risk. If you know your landlord is planning to hike up the rent or a major supplier is looking to raise their prices, your profitability could be under pressure and that will affect your business value. Of course, this type of information might be in the public domain, so it also serves as a warning to buyers and reinforces the need for them to do exhaustive due diligence when buying a business.
Finally, make sure you have an understanding of the true value of the business. Buyers will base their valuation on a formula and if you are basing your valuation on emotional factors (including an amount you need for retirement) then it’s going to be an exhaustive and draining process. You might miss engaging the right buyer because your valuation is unrealistic and months later your next offer is below their offer.
3) A Great Team
In the eyes of the buyer, your staff could be one of your most valuable assets. In fact, the definition of a great business is one that doesn’t require the input of your technical skills on a daily basis. Successful business owners work ON the Business, not just IN the business and they don’t waste time on low level tasks that could be delegated to team members or outsourced.
When Ray Kroc founded McDonalds, he had no intention of working behind the restaurant counter, flipping hamburgers, or cooking fries. His vision was to systemise the business and get his team to run hundreds, if not thousands of take away outlets to produce consistent meals and customer service. This was only possible by recruiting and training team members to follow his processes and procedures. The staff gave him the leverage to grow the business, the profits and ultimately the business value.
A quality and experienced team can add value to the business and smart buyers will focus their attention on your staff as part of their due diligence. Are they good performers? Are they loyal and will they stay on? What relationships do they have with your key customers? If you’re exiting the business with no handover period, who can the buyer turn to for help in running the business? The lesson here is, develop a management succession plan before going to market.
4) Systems, Customer Database Systems
In the digital and social age, your marketing can be the difference between gloom, doom, and boom. Given your customers are the lifeblood of the business, your customer database is an extremely valuable asset and potential buyers will be very interested in the size and depth of your customer data. An up-to-date database that includes your customer’s email address, gender, age and buying preferences will make your business more attractive and valuable.
Buyers target systemised businesses which partially explains why franchises are so popular in this country. They want businesses that have incorporated email marketing and automated systems into their operation. Email marketing is inexpensive and proven to generate repeat business. We hear all the talk of people being overwhelmed by their inboxes, however, that doesn’t mean email marketing is no longer effective. By segregating your database based on your customer’s preferences you can cut through all the noise and tailor offers to their specific interests. Of course, nurturing the relationship with your customers through regular newsletters and updates will keep your brand top of mind.
While it’s an emotional time when selling your business, it’s fundamentally a business decision. Think about what makes your business valuable to buyers including the financials, your team, and your systems. The timing is important so make sure you plan the process to ensure you get the best financial outcome.
If you’re thinking of selling your business, we invite you to consult with us. We can help you get your financials up to date plus assist you to develop a plan and timeline. Most importantly, we can also provide some tax effective advice on how to structure the deal.